More Negativity on the LSI Logic-Agere Merger

Includes: AGR-OLD, LSI-OLD
by: William Trent, CFA

At first glance it may seem as though we spoke too soon when we criticized talk of more semiconductor acquisitions. Soon after a big one was announced:

Consolidation in the semiconductor industry continues apace, with a set of acquisitions in the wireless chip business and another related to storage chips.The biggest deal of the field took place Dec. 4, when LSI Logic (NASDAQ:LSI-OLD) said it would acquire Agere Systems (AGR-OLD), the former semiconductor unit of Lucent Technologies (LU), for $4 billion in stock. The deal is LSI’s bid to boost its presence in the market for chips used in hard drives.

Our article said the reason the deals suggested wouldn’t happen was that the stocks were trading above the 8-10x EBITDA that buyers would likely be willing to pay. Yet the LSI/Agere deal paired two companies with EV/EBITDA ratios (at the time) of more than 14x (Agere) and 12x (LSI-OLD) respectively. So were we wrong?

Not exactly. It is one thing for a private equity firm to pay cold hard cash, as was done in the Freescale acquisition. It is quite another for one company to exchange its own overpriced stock for that of another company. You can see it from the action in the two stocks after the deal was announced. LSI, the acquirer, shed $1.44 per share or $575 million in enterprise value. Although Agere gained $1.51 it amounted to just $255 million in enterprise value due to Agere’s lower share count. Net result: the combined enterprise value of the two companies declined by $220 million despite assurances that the deal would create $125 million in annual cost savings beginning in 2008.

Furthermore, we would hazard a guess that at least some LSI shareholders were hoping to be on the receiving end of a buyout. Instead, the premium paid has left them holding the bag.

Something to think about if you bought a semiconductor stock in hopes it will be acquired.